Airlines:Low fuel prices likely to persist in 1H15 which would imply a positive earnings outlook for airlines

J.P. Morgan Global Commodities Team commented that “the oil market balances for 1H2015 point to a significant build inglobal oil inventories. Thereafter, market fundamentals improve in 2H2015 spurring a small recovery in price. We expect that crudeprices will fall as we approach the March/April period to fresh lows, and potentially the low for this cycle as seasonal refinerymaintenance erodes crude buying and global oil production remains robust. We forecast Brent futures to average $49/bbl in 2015,with a low point in March at around $38/bbl. We expect Brent futures to recover from their 1H2015 lows, to reach an average $58/bblin 4Q2015. We expect 2016 Brent futures to average $57/bbl”.

    Our base case jet fuel price assumptions are US$64/bbl for 2015E and US$72/bbl for 2016E (assuming a US$15/bbl crackspread above JPM Brent futures forecasts) versus the ytd average level of US$64/bbl and spot price of US$72/bbl. We expect theindustry's net profit to double on average and return to above historical average profitability as the reduction/removal of fuelsurcharges are unlikely to completely pass on the lower fuel costs to passengers/shippers, especially with improving industry demandsupplybalance in most markets.

    Weaker local currencies and hedging could partially offset this impact: Weakening local currencies in most Asian marketscould partially offset the gains as fuel costs are largely paid in USD and carriers with high USD debt levels could book F/X losses.

    Please refer to Tables 1 and 2 below for the Asian airlines’ earnings sensitivities to fuel price and exchange rates as well as our recentAirlines Outlook report for each Asian airline’s fuel hedging level.

    More importantly, we expect the operating outlook to become more benign as the industry oversupply gradually comes to anend: We expect the Asia Pacific airlines to grow passenger traffic by c.7.2% in 2015E and c.7.5% in 2016E versus capacity growth ofc.7.3% and c.5.6% based on scheduled aircraft deliveries. Cargo traffic will likely grow c.3.2% in 2015E and c.3.6% in 2016E versuscapacity growth of c.3.4% and c.3.0%. We see lower oversupply risk in the China, HK, Philippines aviation markets and greateroversupply risk in the Singapore, Korea, Taiwan markets in 2015E.

    What is in the price? Asian airline stocks have risen 27% and outperformed their respective market indices by 20% on averagesince jet fuel prices peaked in Jun-14, and have fallen 42% since then to 2005 levels. The airlines’ valuations still have 6% upside totheir historical averages and 81% upside to their historical peaks on average, even though we expect them to return to above historicalaverage profitability. Top picks: Air China, ANA, Cathay Pacific. Top avoids: EVA, CAL.